After the recommendations of the Fourteenth Finance Commission (FFC) forced the government to reduce its plan expenditure in the 2015-16 budget, the Union finance ministry fears its revenues will remain constrained in 2016-17 as well since it has to absorb the recommendations of the Seventh Pay Commission (SPC) in that year.

The SPC will submit its report by October 2015.

“The 7th Pay Commission impact may have to be absorbed in 2016-17. The phase of consolidation, extended by one year, will also be spanning out in this period. Thus, in the medium-term framework, the fiscal position will continue to be stressed,” the finance ministry said in the macroeconomic framework statement laid before Parliament along with the budget on Saturday.

The Union Budget reduced the plan expenditure for the first time in many years by Rs.2,657 crore to Rs.4.7 trillion in 2015-16 from the revised estimate of 2014-15, as the centre shared an additional Rs.1.86 trillion with states. The Finance Commission has raised the untied share of states in net central taxes to 42% from 32%.

The tight fiscal situation forced the government to revise its fiscal consolidation road map and set a less ambitious fiscal deficit target of 3.9% of the gross domestic product (GDP) for 2015-16 against the earlier target of 3.6% set in last year’s budget.

The fiscal deficit of 4.1% for 2014-15 was also achieved through a sharp reduction in plan expenditure up to Rs.1.1 trillion. Finance minister Arun Jaitley in his budget speech said he had deferred the 3% fiscal deficit target to fiscal 2017-18 from 2016-17.

The government appointed the Seventh Pay Commission on 28 February 2014 under chairman justice Ashok Kumar Mathur with a timeline of 18 months to make its recommendations. Though the deadline for submitting the report ends in August this year, the SPC is likely to seek extension till October.

The Sixth Pay Commission which was constituted in October 2006 had submitted its report in March 2008.

As a result of the recommendations of the Sixth Pay Commission, pay and allowances of the Union government employees more than doubled between 2007-08 and 2011-12—from Rs.74,647 crore to Rs.166,792 crore, according to the Fourteenth Finance Commission estimates.

“As a ratio of GDP, it jumped from a little over 0.9% in 2007-08 to 1.2% in 2008-09 and about 1.4% in 2009-10 on account of both pay revision and payment of arrears. However, it moderated to little over 1% in 2012-13,” the Finance Commission said.

The recommendations of the Sixth Pay Commission were implemented by states with a delay mainly between 2009-10 and 2011-12, with “significant expenditure outgo” in arrears on both pay and pension counts, the FFC said.

The FFC said that while the finance ministry projects an increase in pension payments by 8.7% in 2015-16, a 30% increase is expected in 2016-17 on account of the impact of the Seventh Pay Commission, followed by an annual growth rate of 8% in subsequent years.

However, it maintained that given the variations across states and the lack of knowledge about the probable design and quantum of award of the Seventh Pay Commission, it is neither feasible, nor practicable, to arrive at any reasonable forecast of the impact of the pay revision on the Union government or the states. “Further, any attempt to fix a number in this regard, within the ambit of our recommendations, carries the unavoidable risk of raising undue expectations,” added the Finance Commission.

A senior Pay Commission official, speaking under condition of anonymity, said its recommendations will surely have significant impact on the revenues of the central government. “The 14th Finance Commission was at a disadvantage since it did not have the benefit of the recommendations of the Pay Commission unlike its predecessors,” he added.

N.R. Bhanumurthy, professor at the National Institute of Public Finance and Policy, said the FFC has tried to factor in the impact of the recommendations of the SPC on the central government expenses. “The FFC report shows the capital outlay of the central government will dip in 2016-17 to 1.4% of GDP from 1.64% a year ago due to the implementation of the Pay Commission recommendation before it starts rising to 2.9% of GDP by 2019-20,” he added.

The FFC said that all states had asked it to provide a cushion for the pay revision likely during the award period. The FFC advocated for a consultative mechanism between the centre and states, through a forum such as the Inter-State Council, to evolve a national policy for salaries and emoluments.

The FFC also recommended that pay commissions be designated as Pay and Productivity Commissions, with a clear mandate to recommend measures to improve productivity of employees, in conjunction with pay revisions. “We recommend the linking of pay with productivity, with a simultaneous focus on technology, skills and incentives. We urge that, in future, additional remuneration be linked to increase in productivity,” it said.

The Pay Commission official quoted earlier said it has been mandated to recommend incentive schemes to reward excellence in productivity, performance and integrity, which it will do. “Though previous Pay Commissions have talked about linking pay with productivity, the earlier governments have not accepted such recommendations. Since this government has shown strong political will, we hope they will accept our recommendations,” he added.